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ECB cuts growth outlook for eurozone, holds rates

Friday 7 Dec 2012 11:08 a.m.

By David McHugh

The European Central Bank warned of another gloomy year for the 17 European Union countries that use the euro, cutting its forecast for economic growth in 2013 from plus 0.5 percent to minus 0.3 percent.

Even so, the bank left rates unchanged at its meeting Thursday, and ECB head Mario Draghi gave little sign he was leaning toward any more cuts to stimulate growth.

The bank's 22-member governing council kept its benchmark refinancing rate unchanged at 0.75 percent. The rate determines what private-sector banks are charged for borrowing from the ECB, and, through that, the rates banks set for businesses and consumers.

Draghi saw "downside risk to the economic outlook" and said that "weak activity is expected to extend into next year," with a gradual recovery later in 2013. The bank's minus 0.3 percent outlook is the midpoint of the forecast rate of between minus 0.9 percent and plus 0.3 percent.

The ECB's revised forecasts come as the eurozone's economy is caught in a recession - having shrunk 0.1 percent in the third quarter after a 0.2 percent fall in the previous three months. It is expected to contract again in the last three months of the year. A recession is often defined as two quarters of negative growth in a row.

Growth is being held back across the eurozone as governments slash spending and raise taxes. Countries are trying to reduce debt piled up from overspending, in the case of Greece, or from real estate bubbles and banking crises in Spain and Ireland. Greece, Portugal, Ireland and tiny Cyprus have already needed bailouts, while Italy and Spain, the eurozone's third- and fourth-largest economies, teetered on the edge of needing help this summer.

Analysts saw the slashed forecasts as confirmation of more tough times to come for the eurozone.

"This is something that we have been flagging for some time, namely that the eurozone may be headed for a `lost decade,'" said Marie Diron, a senior economic adviser at Ernst & Young.

European share indexes held onto gains after the speech, with the London FTSE up 0.3 percent, Germany's DAX up 1.11 percent and the French CAC 40 up 0.4 percent. The euro dipped 0.8 percent to $1.2967 as some investors thought the dismal outlook raised the chance of a rate cut. Lower rates can make a currency less attractive by lowering returns on interest-bearing investments.

In theory, a rate cut by the ECB could stimulate the eurozone's economy by making it easier to borrow, spend and invest. But rates are already low, and borrowing remains weak. There are very few signs that previous rate cuts and stimulus measures - such as the (EURO)1 trillion ($1.3 trillion) in cheap, long-term loans to banks last December and February - are trickling through to the wider economy.

Draghi said current rates were "very accomodative" - meaning they are low enough to encourage growth.

He also said that that the ECB had already done much to lower rates with its plan announced in September to buy unlimited amounts of bonds issued by of Europe's heavily indebted countries. The purchases would help drive down bond interest rates, which in turn would lower borrowing costs for indebted countries such as Spain and Italy and make it easier for them to manage their debt loads.

The plan has helped stabilize the eurozone debt crisis. Although no bonds have been bought, the mere possibility of the plan being implemented has influenced the bond market. The interest yield on Spanish 10-year bonds is down to around 5.4 percent now, from 7.6 percent in July.

"That is much more than you can achieve by a cut in the policy rate," Draghi said. "We have already done much that is needed."

The ECB chief said that there had been a "wide discussion" on interest rates but that "in the end the prevailing consensus was to leave rates unchanged." Use of the term "consensus" suggests the council was not unanimous and that some members were willing to consider a rate cut.

Analyst Carsten Brzeski at ING said the ECB was putting more faith in tools other than changes in the refinancing rate. He pointed to the bank's announcement Thursday that it was continuing its policy of allowing banks to borrow as much as they wanted at its weekly loan offering - instead of capping the loans.

"The fact that the ECB kept rates on hold even after these strong downward revisions for growth and inflation in our view shows that the ECB prefers to stimulate the economy with non-standard measures and not with additional rate cuts," Brzeski wrote in a note to investors.

But while governments and banks are breathing easier, that hasn't restarted growth.

The ECB's measures are only slowing making themselves felt in the eurozone's wider economy. Some business confidence indicators are beginning to rise and the supply of money in the economy is increasing. But consumer spending sagged 1.2 percent in October, indicating fear and reluctance remain strong.